I am the deputy editor of investing content for Forbes Media. I'm responsible for money and investing coverage on Forbes.com and in Forbes magazine. As editor of the Forbes Dividend Investor newsletter service, I send out two dividend stock recommendations per week and send out weekly updates with the best 25 current buys. I'm also a Senior Editor for Forbes Newsletter Group, including its virtual events business, Forbes iConferences. Prior to joining the company, I spent five years with CNN Financial News working with Lou Dobbs, where I produced long-form pieces and reported on management, entrepreneurship and financial markets. I've also worked for Bloomberg TV and Inc. Magazine.

Don't Sweat Dividend Tax Hikes, Feast On Fat Yields

Valuation of any asset is pretty simple once you make some reasonable assumptions. As a general rule, you’re willing to buy something if the present value of discounted future cash flows is greater than the asking price. Because we live in a world with taxes, it makes sense to take those into account. That’s why there’s intellectual appeal to the idea that if tax rates on dividends go up, investors would not be willing to pay as much for those income stocks as they would with taxes at the present 15% rate on qualified dividends.

The problem with this thesis is that history shows it’s wrong, and that returns on dividend stocks have very little correlation to tax treatment and are much more influenced by the overall performance of the stock market.

Analysts at WisdomTree, the ETF provider, examined how dividend-paying stocks have performed over various time periods marked by different tax rates for dividend income. The last hike in the tax on dividends came in 1993 during President Clinton’s first year in office when the top marginal income tax rate rose from 31% to 39.6%, while long-term capital gains were taxed at a rate of 28%.

What happened? From 1993-2002, the 30% of dividend-­‐paying stocks with the highest yields outperformed those with lower yields, producing a total annualized return of 13.47%, compared to 9.40% for low-yield stocks and 8.54% for the broad equity market. By contrast, high-yield stocks have trailed the total return of the overall market more recently, returning 6.4% annualized from the beginning of 2003 to the end of 2011, versus 7.26% for the overall market. Returns for fat yielders were still more than double those of stocks with the lowest yields.

It is true that the DVY dividend stock ETF has trailed the SPY over the past month, perhaps reflecting fears that dividend tax rates are definitely headed to 39.6% for the highest earners as an emboldened President Obama brings more political capital to bear on budget and fiscal cliff negotiations with Republicans in the House of Representatives. In light of this history, such fears may not be warranted, regardless of what tax rate applies to dividends. Plus, this is Washington, where compromise is the modus operandi for getting things done, so maybe there will be some delay or reduction in dividend tax hike.

Another important reminder comes from the WisdomTree research: about 48% of qualified dividends are paid to people earning less than $250,00, who would see no change in their dividend tax rate if President Obama keeps his pledge not to raise taxes on earners with incomes of less than $200,000. If you don’t make more than that, or if you hold these stocks in an IRA or similar tax-advantaged account, you don’t care what the tax rate is. If you are hit with higher taxes, it looks like dividend-paying stocks, with lower volatility and higher returns, will at least produce reliable gains from which you can pay those taxes.

What’s looking good now for dividend investors? The market’s plunge on Wednesday spiked dividend yields on stocks caught in the sell-off, making banks and defense stocks look tempting, but be careful. JPMorgan Chase has a nice 2.9% yield but could be vulnerable to tighter regulation. Citigroup, Morgan Stanley and Bank of America all have puny yields. Wells Fargo at 2.6% is respectable.

Aerospace and defense stocks face an uncertain future with looming cuts to the Pentagon budget and the spiking yields show the uncertainty. Lockheed Martin is seeing more selling with the yield hitting 5.1%, but insiders there have sold tens of millions of dollars worth of Lockheed shares in the past six months. They are not alone. Top executives and directors at Raytheon, caught up in the defense stock downdraft, have also rung the register aggressively in recent months.

As editor of Forbes Dividend Stock Daily, I need to recommend a dividend stock for subscribers every day. Rather than trying to outsmart the market and speculating on winners and losers of the new Obama term, I’ve gone with companies riding a wave of growth in businesses that will continue to thrive regardless of the occupant at 1600 Pennsylvania Avenue. On Wednesday, I went with server farms and Digital Realty Trust (DLR), a REIT with a 4.9% yield that managed to rise during yesterday’s market storm.

Today I tapped into the wireless infrastructure wave with Tessco Technologies, a company that recently appeared on Forbes’ list of America’s Best Small Companies, ranked by growth in sales and profits, as well as return on equity. Based in Hunt Valley, Md., Tessco is a play on AT&T–which boasts a fat 5.2% yield in its own right–on continuing to maintain and upgrade its wireless network, with the telecom giant accounting for more than 35% of total sales. Tessco provides AT&T and other carriers and government clients with base station antennas, cable and transmission lines, small towers, mobile antennas and other hardware and services to keep data flowing. It also has a retail dividsion that sells handset accessories, like replacement batteries, cases and speakers.

The July-September quarter was a good one, with an expanded relationship with AT&T driving sales 32.5% higher and earnings 48.8% higher than they were in the same quarter of 2011. For Tessco’s current fiscal year that ends in March 2013, the consensus forecast is for earnings per share of $2.06, nearly triple the annual dividend of $0.72, good for a 3.2% yield. The quarterly payout last summer was bumped up from $0.15 to $0.18. With scant debt and a growing business with AT&T, there is plenty of room for that payout to keep on rising over time.

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1.) Even if returns were not affected by the tax rate, you’d still have to pay the tax, so it would still make sense to sell dividend paying stocks.

2.) Your own data demonstrates that higher dividend stocks sometimes outperform and sometimes underperform. So there appears to me to be no rational reason to hold dividend paying stocks. That is especially true if the tax on capital gains is lower than for dividends. But even if it’s not, why be forced into a taxable transaction automatically. If you don’t need the funds, you could let the money ride in a non-dividend stock and only pay tax when you cash in some stock when you need the money. And then, if you’re careful, you might wash those gains with losses and leave Uncle Sam holding the bag.

Your analysis is flawed. Why continue to even address this from that point on. Basically Dividend stocks were already depressed and the small incremental increase that Clinton did then was nothing in comparison to the increase about to go into effect.

Second, you are comparing AT&T versus a huge number of other companies. Now the real yield on AT&T is at 5.2% right now but if you factor in the taxes that are set to go into effect that yield now drops to 3%. HOPEFULLY the rate of inflation. I may as well invest in a CD when everything comes back to normal and people are not fleeing the Euro for safe haven. I have less risk ( even though AT&T is a fairly safe bet ) and my ROI barring growth is the same.

Now you can argue that the stock will simply grow in valuation, but that is less likely for a mature stock like AT&T back in 1998 it was worth $40.00 a share and is now worth $34.00 a share… I mean honestly come on.

I can go further but you seem to miss the real issue that taxation of risk is simply a stupid idea that will cause investors to pull back, place their money in ‘safe havens’ and viola, another decade of stagnation. Keep in mind that we simply do not have a new methodology in reaching people as the lead up in 2000 was. The rapid growth and valuation seen under Clinton was completely different than what it will be by raising taxes now.

Now is the increase in taxes the end of the world? No, is it going to make things difficult… YES!!!!